Separating the Wheat from the Chaff

We noted in our July 31st issue of From the Corner Office (The Golden Era of the Financial Advisor Has Come to an End) that advisors now operate in an era where managerial skill and economies of scale matter at least as much as an their financial competence. The era of the advisor as small business owner is upon us … and a quick survey of the competitive landscape suggests that those who failed to invest in the business during the golden era have a lot of catching up to do. Clients are now more discerning in choosing their advisors and there is plenty of choice. Some of those choices include large firms that invested through the golden era and now possess (a) the name recognition and size to suggest safety in an uncertain world and (b) greater breadth and depth of service, all for the same prices as many smaller firms. While we do not expect dramatic change overnight, we know that clients are steadily separating the wheat from the chaff as study after study concludes that larger firms that have invested in their businesses are growing faster than small firms.

In the early innings of the industry, advisors played on a more level playing field. Most advisors offered similar products and services (led by investment management) and prospects were still under-penetrated. Advisors attracted clients with the promise of rising markets and closed clients based on strong personal relationships and high levels of service. As time passed, differences between firms began to emerge based their level of re-investment, but those differences remained secondary to the powerful attraction of steadily rising markets to prospects and client satisfaction to clients.

Without the cover of a secular bull market, those differences are now more readily apparent to market participants and prospects. The differences reflect business decisions about whether to reinvest profits in the business. In retrospect, one can argue that profits were inflated (“excess profits”) during the secular bull market as rising markets precluded reinvestment in (a) investment management because passive investment strategies were effective and the need for risk management was limited; (b) new business development because AUM rose steadily regardless; and (c) client service because happy clients often do not want to meet with advisors let alone need hand holding. The consequences of those decisions are reflected in the three groups of advisors we see in the business today.

Large Firms. Some firms re-invested those “excess profits” in the business to develop the next generation of advisors who will be responsible for future growth, to expand the breadth and depth of services and to create the back office efficiencies and scale to support future growth. As investment returns decline, these expanded planning products and services become an important basis for differentiation. Consider that clients must now spend less and save more to compensate for disappointing investment results. Advisors must therefore offer a broader set of financial planning and life coaching services to remain relevant by helping them (a) adjust financial expectations, (b) adjust spending and saving behaviors and (c) stretch their dollars. The role of the advisor is shifting from the “Candyman” to the “Doctor”: less candy (spend more and save less due to the miracle of investing) and more medicine (spend less and save more). Note that most people are more careful when choosing a doctor.

One Trick Pony. Other firms increased spending on their “money-maker” – investment management – often at the expense of business development and other financial planning services. Clients responded to an advisor’s investment acumen so building the firm around the investment function made sense. With that said, some of these firms also found investment management a more comfortable role than new business development where regular rejection can be frustrating. Perhaps the most important consideration today is that a value proposition so narrowly focused on investment management places the firm at risk of client disappointment when the market does not cooperate. In a secular bear market, even the best managed portfolio may produce returns substantially below the levels clients were trained to expect during the secular bull market. This issue becomes especially concerning when one considers the fact that most clients cannot tell the difference between good managers and bad managers making competitive differentiation that much more difficult.

Along for the Ride. Still a great many other advisors took profitability for granted. Instead of employing those “excess profits” to build their businesses, they assumed those “excess profits” would continue indefinitely — as markets were expected to rise indefinitely – and took those “excess profits” home.

This dynamic may have competitive consequences. Large firms may now be advantaged: not because they can sell prospects better or develop better client relationships or service the clients any better, but because their value proposition is more resilient in a difficult investment environment and more robust from a price-for-service standpoint. We make several observations:

Clients are Now More Discerning. When times are tough, people are more careful with their limited resources, especially financial resources. Today everyone is focused on value. In his remarks at FPA Experience, Bernie Clark noted that clients are now interviewing 8-10 advisors and choosing 2-3 advisors. In years past, they interviewed 2-3 advisors and chose one. Competitive differentiation is paramount.

Large Firms are Growing Faster than Small Firms. Those firms who invested all along have better brands (name recognition, greater perceived safety in an unsafe world), a broader and deeper product set, and the resources to promise better service. By offering a more robust value proposition at the same prices, these firms have raised the ante for consideration by prospects even before personal relationship and service are considered.

Clients Remain Willing to Pay for Value. The good news is that studies and anecdotal evidence alike indicate that clients are still willing to pay for value. We are hearing that large firms with robust value propositions have maintained pricing through the secular bear market. We are also hearing that some smaller firms are trying to raise prices from discounted levels to compensate for a decline in AUM and revenues. Those with robust value propositions are succeeding. Those with less robust propositions are seeing price declines. Specifically, those firms that only offer investment management are finding that competitive differentiation is low and are sometimes cutting prices to win business.

While that ground cannot be recovered overnight, there are steps emerging advisors can take to remain competitive: in terms of both attracting clients and maintaining pricing in a difficult environment.

Offer a Broader Product Set. Make sure you are offering a competitive product set in terms of both breadth and depth: retirement planning, tax planning, estate planning, insurance planning, divorce planning, elder care planning, business succession planning. While you may not be able to support those capabilities in-house, you can certainly bring to bear best-in-class capabilities via partnership and/or referral. Apple Computer serves as a good example in this regard. Apple did not manufacture all the components of its computers. Rather it decided what the customer wanted / needed and brought to bear those resources to provide the optimal solution … one the customer may never have conceived was possible. By quarterbacking the solution so well, Apple charged a premium for decades. Some of these capabilities can be brought to bear virtually by developing relationships with the local attorney, insurance firm and accountant. Others can be brought to bear via outsourcing like investment management.

Free Your Time for the Client and Business Development. Once a competitive product offering is in place, competitive differentiation will return to client relationship and client service where large firms typically have less of an advantage over small firms. The key is to structure the business on a virtual or outsourced basis so your time remains free to focus on the client, client solutions and new business development.

If your firm faces these issues, considering contacting us at Pinnacle Advisor Solutions. With more than 20 years experience building our own RIA to nearly $1 billion, we may have a few ideas about how to help. More to the point, Pinnacle Advisor Solutions has assembled an exceptional team to provide virtual and outsourced solutions for your investment and back office needs.

Author: Peter McGratty CFA

Peter is co-founder and Vice President of Strategic Partnerships of Pinnacle Advisor Solutions. With more than twenty years of experience in finance Peter is responsible for all aspects of the business including sales and marketing and business development.